Chartalism and Stock-Flow Consistency: A Reply to Nick Rowe

poster_stock_flow-resize-710x399I promised a reply to Nick Rowe’s post in which he proposed that the neochartalist (NC) view of currency suffers from a stock-flow inconsistency.

I’m moving house, going to farewell events, enjoying a visit from my parents, and marking exams at the moment. So this isn’t going to be a very detailed reply. Anyway, I’ve been told to go in a less technical and more humane direction with my blogs, which suits me. But I did promise a reply. And I have a gap in my marking schedule. So here we go.

Rowe takes issue with the NC claim that the state, by imposing a tax payable only in a given currency, gives value to that currency. “Value” is a nightmare word from a philosophical point of view. Let me restate the claim thus. The answer to the question: “Why is there demand for currency?” is: “Because it is needed to pay taxes.”

Rowe comments as follows:

There’s a problem with that answer. Taxes are a flow; they have the units $/time. Taxes create a flow demand for intrinsically worthless bits of paper. But there is a stock of intrinsically worthless bits of paper; and that stock has the units $. And if that stock of paper is strictly positive and increasing over time, as it usually does, that means the flow supply of new paper created must exceed the flow demand for paper to pay taxes. So if flow supply exceeds flow demand, why doesn’t the market price of those intrinsically worthless bits of paper fall to zero?

I agree with that. If the government spends $2 for every $1 it taxes back, then a stock of dollars is building up somewhere. If people didn’t want to be building up that stock, then they would be spending the dollars, and the dollars would find their way back to the government as tax payments. Since that isn’t happening, clearly people want to build up their stock of dollars. There is a stock demand as well as a flow demand.

But I’m not sure I understand Rowe’s complaint about this. I think his point is that taxes can explain the flow demand but not the stock demand, so that the NC theory can’t be the whole truth. The fact that people need X dollars/year to pay tax explains why people are willing to give up goods and services for dollars. If people on the whole end up accumulating dollars in excess of X/year, there must be some other reason for wanting dollars. There is, but only in this sense: people are always unsure about precisely how many dollars they need each year, and they overshoot to be on the safe side.

In a world of perfect certainty, there would be no need to accumulate dollars: people would spend all their dollars (or whatever currency) buying what they need today on the spot market and everything they need tomorrow on the forward market. Cue the requisite Keynes quotations about money as the barometer of uncertainty.

Rowe then asks what it means for velocity if the state runs continued deficits and the price of currency is not falling.

Here we can think of velocity as the flow of currency out of the economy (tax payments) divided by the total stock of currency. As Rowe points out, the dimension of the velocity variable is 1/time. The variable for the flow of currency out of the economy has the dimension $/time, and that for the stock of currency has the dimension $. So construing velocity as the first divided by the second gets us to the right dimension.

Rowe rightly points out that if the state runs continued deficits, and the new dollars are added to the stock of currency rather than being spent, then velocity must be decreasing. But what, he asks, explains this continued decrease in velocity?

I think this is the same complaint in a second incarnation. A slowdown in velocity is, effectively, the building up of a stock. So again Rowe is suggesting that NC theory has no explanation for the building up of the stock. This time, he proposes an alternative theory:

The simple textbook’s ISLM model has a clear and simple answer …. It says that velocity is a positive function of the opportunity cost of holding money, so if money always pays 0% interest, a rise in the rate of interest on other assets will cause velocity to increase. You might not agree with that answer, but it is an answer.

Is it an answer? It seems to me to have no operational content. The rate of interest on an asset is a function of forward price / spot price: how much people will pay for the asset in the future relative to how much they pay for it today. So to say that velocity will increase if the rate of interest on other assets rises is just to say that if people will spend more on assets tomorrow then they will spend more on assets today. Increase in velocity today is explained by increase in velocity tomorrow. Tomorrow’s increase now stands in need of explanation, and if it is explained in the same way as today’s increase then we are embarked upon a regress in danger of collision with the heat death of the universe.

Cue quotations from Joan Robinson about how economic propositions dissolve into meaningless noises or circular arguments. I’ll stick with the NC theory until a contentful alternative comes along.

The primary cause of poverty, as a wise president once said, is lack of money. People need currency to buy what they need. Those who have what they need will only give it up for currency. Why? Because they want currency to supply their needs, and those who have what they need will only give it up for currency, for just the same reason. There is a chain of dependence, but it is well-founded. At the end you get to those who want currency because they need it to pay taxes or are uncertain about their future expenses and build up a buffer to be on the safe side.lewis_carroll_-_henry_holiday_-_hunting_of_the_snark_-_plate_6

Poverty exists, in other words, because the flow-supply from the currency issuer is inadequate to the flow-demand created by taxation plus the stock-demand created by uncertainty. Increase the flow-supply, or reduce the flow-demand, and the problem goes away.

Another option is to try to reduce the stock-demand by reducing uncertainty. Most central banking operations boil down in the end to such an attempt. But it is a most impalpable Snark-hunt, and while the central banks are busy trying to charm Uncertainty with smiles and soap, or threatening its life with a railway-share, the government could just be increasing spending or cutting taxes.


20 thoughts on “Chartalism and Stock-Flow Consistency: A Reply to Nick Rowe

  1. NeilW

    The insurance industry is a thing. Doesn’t that suggest something about uncertainty?

    But what do I know. I’m just a simple engineer.

  2. NeilW

    “Poverty exists, in other words, because the flow-supply from the currency issuer is inadequate to the flow-demand created by taxation plus the stock-demand created by uncertainty”

    Slightly wider than that I feel. The flow-supply from the currency issuer *and their tame bankers* is inadequate to the flow-demand created by taxation, loan repayments and the stock demand created by uncertainty (particularly uncertainty over taxation, loan repayments and interest on loans).

    Loans are no more patient than taxation. They have to be serviced on pain of some punishment or other. Loans are essentially a privatised form of taxation that you voluntarily sign up to. And in a lot of cases, not so voluntarily. Both drive up feelings of uncertainty.

    There may even be some benefit in investigating. Do equivalent ex-students without student debt have more or less net savings than ones that do?

  3. Nick Rowe

    Alex: Thanks for the reply.

    OK, you have added a precautionary/transactions demand for a stock of money to pay taxes. That’s fine, and solves the stock/flow problem with the Neo-Chartalist theory. But why can’t we say there is a precautionary/transactions demand for a stock of money to pay for *everything* we buy with money, not just pay taxes? So I would want to hold a stock of money to pay for gas, car repairs, groceries, etc. etc. even if I was a tax-evader who never paid any taxes? Taxes are just one of many things whose exact timing and magnitude are uncertain that we need money to pay for. So even if taxes disappeared, those other stock demands for money would remain, and be sufficient to explain why (intrinsically worthless) money has positive value.

    (And empirically, so I’m told, tax evaders hold more currency on average than people who pay taxes.)

    Taxes might (or might not) be the thing that gets the ball rolling, but once it is rolling it keeps going.

    BTW, we should perhaps talk about the “price” of money (in terms of goods and services, which is just the reciprocal of the price of goods and services in terms of money), rather than the “value” of money, because, yes, “value” can mean many things. And monetary economists do often say “price” of money meaning this. But some people confuse “price of money” with rate of interest, so often we say “value of money” instead.

    1. mrkemail2

      Pretty much. Income and outgoings are not matched – which needs a ‘working capital’ buffer. The more uncertain and irregular your income the bigger the buffer you need. Humphrey Bogart called this his FUF. “FU fund”.

      Secondly the future is uncertain, but taxes and debt need servicing at a regular interval. Again the more precarious you feel your position is, the bigger “rainy day fund” you require.

      And thirdly there is vanity. How big is your wad. You could call this the LoadsaMoney principle.

      So essentially time buffer, insurance and vanity are the reasons to hold cash.

      The cash you carry around in your wallet is a time buffer. Multiply that by millions of people and you have a lot of ‘saving’ that is easily explained if you think in terms of human beings rather than mathematical equations.

      And most people don’t even know what the interest rate is on the majority of their money. Hence why banks have loads of money in crap paying deposit accounts.

      Similarly businesses go for convenience rather than income with their cash buffers.

    2. axdouglas Post author

      Thanks, Nick.

      Yes, the non-chartalist story is logically consistent. Citizen A wants the currency to buy things from Citizen B. B accepts the currency because she wants it to buy things from C. And C accepts it because he wants it to buy things from A. No taxation is needed to support the currency.

      But then why would A, B, and C use the *state* currency for these transactions? They could just as well use, a private currency. The dominance of the state currency over all complimentary currencies is explained, in the NC story, by the fact that only the state currency can be used to settle tax liabilities.

      Once you have the state currency dominating others, the explanation of recessions becomes easy. The state, as issuer of the currency, isn’t supplying enough of it for everyone who wants to sell their labour for a money-wage to be hired.

      Thanks for explaining the use of the term “value of money”. I now understand.

      1. Nick Rowe

        Alex: yes, it’s one of those network externality things, like languages. If one big player insists on speaking English, that makes it more likely the smaller players will switch to English too. And the government is a big player in the money game. But we also see some people using foreign currencies (like in Cuba, where the US dollar was banned, but people still used it for some transactions).

        I agree that recessions are explained by an excess demand for the medium of exchange. (But it’s not just labour that cannot easily be sold in a recession; what happens in the labour market is just one (big) example of the difficulty of trading everything else for money, when there’s an excess demand for money. And in support of our theory, we sometimes observe people desperate enough to resort to barter, despite its difficulties.)

      2. axdouglas Post author

        Yes, so another way of putting the NC point is as follows:

        During a recession there are various sorts of market failure (A has labour/wants food, B has food/could use the labour). Why don’t they solve the problem by switching to barter, or issuing their own IOUs or whatever? And here taxation is the answer – or, more generally (as Neil writes above), the answer is that people have liabilities fixed in terms of the state currency.

  4. PeterP

    With the same argument Nick could prove that bus tickets do not get value from being accepted as a pass to ride. Hey, ticket collection is a flow, and a pile of tickets is a stock! Same for movie tickets. Dishonest sophistry.

    This is typical for Market Mnetarists, they basically show off how smart and articulate they are while creating nothing actionable. Society should not pay them to instead of advancing knowledge, to use the perch for status games.

  5. Brian Romanchuk

    It’s much simpler. You made the mistake of accepting Nick Rowe’s incorrect assumptions (as eluded to by PeterP).

    If everyone was in an identical situation, his argument would appear to hold. But if everyone were identical, there would be no motive for any transactions whatsoever. And if we glance out the window, we see that people are not in identical economic situations. Any theory based on total equality at all times is farcical.

    Once we introduce asymmetry, money has value. If I have money and no taxes due, and you have no money and tax due, I know that money has value to you. I am only going to give you money in exchange for something I value; the exchange ratio is based on what I think the market will bear.

    In the real world, we have fixed debt and nominal price contracts, which further acts to cement the exchange value of money.

    1. axdouglas Post author

      Brian, I agree with all of that, but isn’t it just the same thing I described in my third to last paragraph?

      1. Brian Romanchuk

        Yes, looking at it again, the logic is close. However, my feeling was that his argument hinges upon the assumption that people are identical, and that we do not need to add in a lot more theory to see why his argument will not hold up. The risk is that we start getting sidetracked by discussions of velocity, uncrtainty, future generations, etc.

  6. grkstav

    If A is variously (i.e. it does not have to be BOTH necessary AND convenient at the same time for everyone) necessary AND convenient, prudent (they do not have to be pristinely rational) agents will desire it and will seek to accumulate it.

  7. mrkemail2

    “Rowe rightly points out that if the state runs continued deficits, and the new dollars are added to the stock of currency rather than being spent, then velocity must be decreasing.
    Money being ‘spent’ is still part of the stock of currency. No matter how often it gets spent between people, at any given instant it’s in the stock of savings.”

    Hmm. Contextually, maybe the “being spent” meant spent out of the private sector back to the government through taxes. But in that case, you still don’t necessarily have velocity decreasing if the stock of money within the private sector is increasing. More money with the same velocity could exist with greater output or greater prices, as the old identity shows.

  8. coolslim

    ‘Poverty exists, in other words, because the flow-supply from the currency issuer is inadequate to the flow-demand created by taxation plus the stock-demand created by uncertainty. ‘

    Yes, poverty is mostly caused by austerity.

  9. Jerry Brown

    I’m not big on inhumane bloggers, so I’m glad you are changing direction there. But who told you to be less technical?

    Joking aside, I am having trouble with the idea that poverty exists because the currency issuer (the government, I presume) just doesn’t issue enough pieces of paper. I am sure I’m missing something, could you explain that a little more? Unemployment, I can understand, but not poverty. I can see how the government might bring poorly used, or unused, or poorly distributed resources into better use if there was a lack of demand by issuing more money, but issuing more money isn’t going to create more resources if they just aren’t there in the first place. At least not overnight.

    1. grkstav

      “Poverty exists [in a monetary economy, in which access to the means of subsistence is mediated through money], in other words, because the flow-supply from the currency issuer is inadequate to the flow-demand created by taxation plus the stock-demand created by uncertainty. “

    2. NeilW

      “but issuing more money isn’t going to create more resources if they just aren’t there in the first place. ‘

      If you go to the hairdressers with a newly minted note, do they turn you away or work longer/harder/faster to cut your hair and earn that note?

      The resources are generally there. The estimates of output gaps are wildly low because of the way classical economists think, and in fact we run economies practically on tickover because of the way they see things. Certainly in the service sector. And are we really running manufacturing on maximum overtime?

      The general line should be that increased spending is to be ‘paid for’ by increased production, and that any price rises will be treated with ‘competitive measures’ – the state investing to set up competitors that price compete, breaking up cartels or increased taxation. Get that right and you’ll go a long way before you actually fill anything up.

      1. axdouglas Post author

        That’s so weird when people say that, isn’t it? Imagine someone in a business meeting saying: “Offering people overtime to work on Saturdays isn’t going to work (even though we have the money) if the labour resources aren’t there in the first place.”

  10. NeilW

    Probably worth noting that the Schelling Segregation model demonstrates why currency preference is pretty hard either side of a border. Just the simple fact of writing the prices in one currency or another is probably enough, never mind taxation or debt denominations.


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